Reliance, Inc. (RS) Earnings Call Transcript & Summary

Let's get started. I'd like to introduce you to Jim Hoffman, the President and CEO of Reliance Steel & Aluminum; and Karla Lewis, SVP and CFO. And Jim and Karla, thanks for your participation in today's conference. We're excited to hear from you about the business and outlook. Before we get started, a quick disclaimer. Please note that this webcast is for Morgan Stanley clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you're a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. And with that, I'll hand it over to you, Jim and Karla.

Great. Thank you, Matt. Good morning -- or good afternoon, everyone. Thanks for joining us today. My name is Jim Hoffman, I'm the President and CEO of Reliance; and presenting with me virtually today is Karla Lewis, Reliance's Senior Executive Vice President and Chief Financial Officer. What I'd like to do is, kind of, give you a high-level overview of Reliance and then open the floor up to questions. Please note that the information that we are going to share today will be webcast live on the Investors portion of our website at investors.rsac.com and is subject to Regulation FD. Reliance is a leading diversified metal solutions provider. We are the largest processor and distributor of metals in North America, and we play an intricate role in the industrial supply chain. During our 80-year history, through both acquisitions and organic growth, we have grown to over 300 locations in 40 states and in 13 countries outside of the United States. While Reliance is not a metals producer, we are significantly -- or strategically located near both metals producers and our customers to optimize logistics and help minimize our carbon footprint. Our most important core value is our safety and sustainability. We are dedicated to the health and safety of our employees, customers, suppliers and our communities as well as to ensure that our operation has minimal impact on the environment. At Reliance, customer service and quality are the cornerstones of our success. We focus on smaller customers who value our ability to provide higher-quality products and services in small quantities on a frequent when-needed basis. In 2019, our average order size was approximately $2,100, and approximately 40% of these orders were delivered within 24 hours of our customers placing that order. Because we cannot control external factors, such as end market demand and global metals pricing, we focus on the areas we can control, which has produced positive earnings per share every year since our 1994 IPO, even during recessionary periods. We believe this business model -- these business model differentiators serve as key competitive advantages and sets us apart from our peers. First, we are highly diversified in terms of products, customers and geographies. We maintain a decentralized operating structure. Our individual businesses benefit from our scale and supplier partnerships while maintaining customer relationships at a local level and operating in an entrepreneurial setting, ensuring that decision-making and resources are kept close to our customers. We emphasize when-needed inventory management, ensuring that our inventory quantities reflect the current demand levels, and we incentivize our managers closely against this matrix. We focus on higher-margin business. Our managers in the field are responsible for pricing discipline and expense control and understand the value they provide to our customers. We also have a minimum -- we have minimum contractual sales. We do not speculate, hedge or buy large quantities of import material. We conduct our business predominantly on a spot basis on both the buy and the sell side, meaning we buy what we need when we need it. And finally, through our emphasis on organic growth and innovation, we continue to make significant investments in our business. We are highly focused on innovation, investing in state-of-the-art processing equipment in order to provide even more high-quality services to our customers while simultaneously improving our gross profit margin. In 2019, we performed value-added processing on 51% of our orders, up significantly from our more historic levels of approximately 40%. This helped result in an increase in our estimated sustainable gross profit margin to a range of 28% to 30% compared to our historical levels of 25% to 27%. Thanks to the hard work and strong execution of our managers in the field, in 2019, we generated net sales of $10.97 billion and achieved a record annual gross profit margin of 30.3% that drove record annual gross profit dollars, record pretax income and record earnings per diluted share. Our strong profitability and focus on working capital management generated record cash flow from operations of $1.3 billion. The resiliency of our business model was tested in the second quarter of 2020. However, the continued strong execution of our core principles helped us maintain a strong gross profit margin of 30.4% with positive earnings and generated cash flow of $475 million. Importantly, our business model enables strong cash flow generation throughout economic cycles. This cash flow generation and access to capital provides us with the flexibility to allocate capital across capital expenditures, acquisitions, dividends and share repurchases. In summary, we have a strong and resilient business model, coupled with a healthy balance sheet and cash flow and provide the ability to successfully execute in all environments. In today's environment, we believe Reliance's position in the supply chain has never been more important as our customers rely on us to do even more for them. And with a renewed emphasis on the importance of dependable infrastructure, America is going to need Reliance to rebuild. Thank you for your time and attention today. Now we can open the floor up to questions. Thanks, Matt.

Well, Jim, that's fantastic. And very interesting thoughts. I guess I'd also open up to the group here on the call as far as if they have any questions, but just to get the ball rolling. You highlighted this a bit, but Reliance really has had pretty consistent margins for months and quarters and years and very strong margins as well. So just a couple of thoughts, if you could kind of talk a little bit more about what do you credit that to? And what do you think investors really misunderstand about your company, kind of, in that context?

Well, I'll take that. That's 2 great questions. As far as the gross profit, we attribute that to our plan. 8 years ago, we decided that you need to be more than just a distributor of metal, and we got into -- heavily into the value-added end of the business. We spent a lot of money, over $1 billion because we thought that was a better place to be. You can make money doing that, and our customers' assets to do it. I mean when we come through situations like we're in right now, our customers come out of that asking us to do more and more on the value-added end and we accommodate that. Throughout this pandemic, we continued to spend money on our value-added client. However, we did reel it in a bit. I think our original plan was to spend $250 million, and we ratcheted that back to $190 million. But -- and -- but we kept a focus on that value-added into the business. So we think that is a major part. Certainly, the price discipline of our managers in the field. They recognize what they do for customers is important. Our customers recognize it. People don't buy from Reliance if you want the lowest price. That's not what you're going to get. If you want something when you need it and you need it, of high-quality, you're going to call Reliance. So that's why we think we're able to do that. Our inventory control, we've recognized for a long period of time that having the correct amount of inventory is in direct correlation to your margins. So if you have the right inventory instead of too much inventory, you're able to take good orders and add value to that. So that's the margin side. The other side, you asked about what I think so what's frustrating about what people think about Reliance. I'm here to say we are not a metals producer, all right? We do not make metal. We buy metal from domestic suppliers who are great. They're awesome at what they do, completely different model. It just -- it's always interesting to me when I read an article about Reliance and right next to Reliance, there's a picture of a blast furnace. I don't know why. I guess they're old photos. Maybe folks need to, kind of, come up with some new photos. But Reliance is not anything close to being a producer of metal. We are a value adder, and we provide a value-added product to our customers when they need it, and sometimes, 40% of the orders, literally are the next day. And you can't do that if you're simply making -- not simply. If you're making product, you can't do what we do. So...

Yes. And if I could add, Matt, this is Karla, I think, one thing on the gross profit margin. Certainly, everything that Jim talked about with our gross profit margin has helped us raise that and sustain it. We do operate in environments where we have some cyclical end markets and deal with some pricing volatility. So on top of that [indiscernible] from our managers in the field, we do use LIFO accounting, which helped level off our gross profit margins based on volatility in metal pricing. That helps us sustain that more consistent range. And I think just on the -- Jim explained, we're not a metals producer, and we really think that our model works well. We really have tried to position ourselves less as a metals type company and more of an industrial distribution type company. We think -- and in the slide deck that's available for all of you, there's some charts showing that our results are consistent with the industrial distribution group and some of the metals groups. And so we just encourage you to look at that and maybe think about Reliance a little differently. Look at the resiliency of our results, our cash flows, look at our small order size and how we are able to consistently manage through that.

Great. Thanks, Karla. And this one maybe for you. The next question is, can you elaborate on the strength in your cash flow from operations during the second quarter? And as you think about the outlook for the business as well as the balance sheet, how do you think about capital allocation priorities now? And has this been impacted by COVID at all?

Yes. So certainly, we did have strong cash flows in the second quarter. But really, we had -- as Jim mentioned earlier, we had record cash flows of $1.3 billion in 2019 and very strong cash flow in the first quarter of 2020, which typically, we use cash in the first quarter from a seasonality standpoint because we're typically rebuilding working capital. But these higher margin levels have allowed us to throw off higher levels of cash flow from operations. We also really focus on managing our working capital. When we went into the pandemic, in April, on our first quarter call, we did state then that we had a focus on reducing our inventories. We felt we were in good shape. But with the uncertainty and expected downturn in shipment levels, we did focus on reducing inventory in the second quarter. So that contributed quite a bit to our strong cash flow from operations as did our accounts receivable. As our shipments declined, that fell also. So working capital threw off quite a bit of cash during the second quarter. During that first quarter earnings call, we also mentioned that because of the uncertainty, we were going to look at cash preservation. We did ratchet down our 2020 capital expenditure budget from $250 million to $190 million, just to give us that -- because, a, we have the flexibility and to give us room, not knowing how bad things get. But overall, we performed well. We were able to continue operating and providing our essential customers products throughout. And coming out of the second quarter, we feel that the worst is behind us. We feel we can handle whatever is coming next by continuing to execute that business model. So we really got rid of that cash preservation mindset because we're confident. So we're ready to execute across all of our capital allocation strategies. We're -- we look at first 2 buckets of our 4 buckets as growth-related. So we are growing organically through our capital expenditure spend, putting in more value-added processing equipment. And other type of asset acquisitions is the other part of our growth strategy, which we completed 67 acquisitions since 1994. We're seeing a lot of opportunity, but we're very selective on which companies we go after and bring into the Reliance family. They need to be immediately accretive to earnings, cash flow positive, strong companies. We continue to look for those, and we hope to continue to acquire some more companies to add to our growth. And then the last 2 buckets are on stockholder returns. And we have a regular quarterly dividend that we've consistently increased over time. We increased it again in the first quarter of 2020, and we've never reduced the amount or stopped paying the dividend. So we continue to pay our dividend. And then we look at share repurchases, and we execute on that opportunistically. We'll go in and out of the market as we think makes sense. And we're in very strong shape financially. Our balance sheet is very strong. We have lots of room to execute on all 4 of those strategies, and we'll continue to look and execute when we think it makes the most sense.

Great. Thank you, Karla. And I guess it's a good segue to the next question with regard to M&A. I mean, as you, kind of, look at your pipeline and over the course of 2020, has there been more opportunities that you guys see in the pipeline and just out there in the market? And I guess in that context, what do you guys focus on as far as end markets, products, capabilities? And so what kind of lens do you take to M&A as you guys look at acquisitions, a potential deployment of capital in that arena?

I can tell you, Matt, that the pipeline is full. There's plenty of activity in M&A. I can't tell you how many we've looked at. Karla could probably give you a number, but it's a big number. And we looked at 80-some last year and bought one. And I -- we may have even looked at that many already this year, and we have not pulled the trigger yet. Our entry point to become part of the family of companies, it has not changed. We're just not going to do that. We're not going to buy a fixer-upper. It has to be immediately accretive. It has to be a company of high integrity, has to have a great reputation. We like when they have a deep bench. We like when family members stay with the company. We keep the name of the building that they're family on the side of the building, it's important. These companies -- we own the 67 different acquisitions that Karla mentioned, they all -- the majority of them have the same name because that's important to the owner. A lot of these companies are -- an example, grandpa might have started, dad ran it and the kids don't want any part of it, so they sell it. Now in this situation we're in right now, I don't know. I can only speculate why there are so many. Some of them probably are worried about elections and taxes and things like that. But I can tell you, there's plenty of them to look at. There are some good ones. There are some very small ones that are good, that may be a little too small for us. But we look at them all. We're very cognizant of not competing with our suppliers. We don't want to do that. That's their business. They're good at it. We like when they make money. We're going to stay out of their basket, if you will. And we don't like to compete with our customers either. So we're aware of those types of things, so some companies get kind of pushed out because of those things. But we're going to continue to look, and it is still a major part of our strategy. And another thing we don't do, we don't sit down in the beginning of the year and say, "Gosh, we only bought 1 company last year. We should buy 5 this year." We think if we did that, that would lead us down a dark path and probably make us do a bad acquisition. And we don't like bad acquisitions. There's plenty of good companies out there. It's just a matter of us finding them, them finding us. There's companies that we've been courting, if you will, for a long period of time, just tremendous companies. It's just a matter of when they're ready to sell. And the good news is we positioned ourselves to be ready to pull that trigger when we need to do so. And we work real hard on these, and we're going to continue to do so because it is -- like I said, it's one of our major parts of our growth, along with internal growth. And then other thing does come into consideration since I've said that is we're of a size now where instead of going out and paying a premium for a company and buying it, we can simply take one of our known commodity part of our FOC and add some value-added equipment there and increase our market share that way as well. So there's a lot of ways to do it, but acquisitions are still -- there's plenty of them out there to look at. I can tell you that.